PCI Construction Inc. June_2000_Backgrounder CMA Exam

June 2000 CMA Entrance Examination – Part 2 – Backgrounder

Copyright © 2000 by The Society of Management Accountants of Canada. All rights reserved.This material, in whole or in part, may not be reproduced or transmitted without authorization.

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PCI Construction Inc.Backgrounder

Introduction

PCI Construction Inc. (PCI) is a retailer that sells lumber and building materials to contractors aswell as hardware products directly to consumers. PCI, a private company, currently operatesfrom three outlets in the Cedarville area, each of which consists of a lumberyard where lumberand building materials (such as finished wood, dry wall and related products) are stored, plus anadjacent hardware store. PCI began as an exclusive family business many years ago, and hasconsistently expanded over the years to attain its current position in the industry.

PCI is considered to be a solid competitor and a major player in the business of selling lumberand building materials to contractors. A tradition of good service to contractors has been a key toits growth and resulting expansion, and has ensured a solid base of loyal contractors. However, itis considered to be a more limited competitor in the retail hardware industry. Intense competitionfrom both local and foreign-owned hardware store chains and recent developments in the retailhardware market have somewhat eroded PCI’s historic position in this aspect of its business.Nevertheless, a customer-oriented approach has helped it maintain a reasonable share of thismarket and continue to be profitable in it.

Company History

PCI began its operations in the early 1950s as a single hardware store adjacent to its head officelocated southeast of the city of Cedarville in the rural region of Kellerton. It was founded byOliver Parsons, whose original mission was to supply local farmers with tools and hardwareproducts that were required to facilitate growth in the agricultural industry. At that time, duringthe post-war era, economic conditions were conducive to growth in this industry, and mostfarmers responded by expanding through the acquisition of land and by building new barns andother storage facilities. As a result, there was considerable demand for hardware products such asthose provided by PCI.

Subsequently, PCI expanded by adding a lumberyard to its original Kellerton store. Thereafter,Oliver sought to satisfy customer demand specifically in neighbourhoods within the Kellertonregion that were experiencing rapid growth in construction. After securing PCI’s market positionin the Kellerton region with this approach, Oliver built a similar facility in Westbrook, a trendyarea in the western part of Cedarville, in the early 1960s. At that time, new construction wasbooming in this area and homes previously built there in the 1930s required upgrading. PCI’sWestbrook hardware store and adjacent lumberyard thus served to satisfy the needs of areacontractors and residents keen on home improvement.



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During this period of growth, Oliver invited his son Phil to join the family business. In 1955, hehired him as a clerk in the Kellerton hardware store. In spite of his lack of post-secondaryeducation, Phil progressed well at PCI on his own merit to the point that he was promoted toundertake the task of managing the Westbrook store as soon as it opened. Subsequently, whenOliver retired in 1979, he sold his shares in PCI to Phil, who by that time had become anaccomplished manager, having learned the principles of management “the hard way.”

Like his father, Phil favored further expansion of PCI. However, unlike his father, who wasgenerally reluctant to delegate, Phil decided that his plans would have a greater likelihood ofsuccess if he developed a management team that could assume various tasks and sit on the boardof directors. Thus, he intended that each team member would also be a shareholder. To ensurethat PCI would remain at least in part a family business, he first asked his younger cousin,George Goodrich, to join his management team. Next, he recruited two of George’s friends,Réjean Pedneault and Peter Martin, to complete his team.

The responsibilities of PCI’s new management team at the time were as follows: Phil Parsons,President and Chief Executive Officer; George Goodrich, Vice-President, Marketing; RéjeanPedneault, Vice-President, Finance and Controller; and, Peter Martin, Vice-President,Purchasing.

According to an agreement among the members of the management team, each new teammember had to commit to the firm’s future success by buying common shares of PCI. Inaddition, a shareholders’ agreement stipulated that should any of the shareholders wish to selltheir shares in whole or in part in the future, he or she would be obligated to offer them first tothe other shareholders, who would then have the opportunity to bid on the shares. In the eventthat none of the other shareholders were interested in buying his or her shares, PCI would thenhave the right to buy back the shares at their book value. To ensure that control of the companyremained within the Parsons family, Phil offered more shares to his cousin George than toRéjean or Peter.

Throughout PCI’s history, the shareholders’ agreement worked very well. It was put to the testonly once by the Kellerton store manager. Prior to Phil’s appointment as President, shares hadbeen given to managers as a bonus according to the company’s performance evaluation plan. Inthis case, the Kellerton store manager, who had accumulated a number of shares over the years,decided that he would prefer to receive cash for his shares rather than have a portion of hiswealth tied to PCI’s future. The new Westbrook store manager who succeeded Phil and did notyet own any shares, offered to buy these shares; however, according to the shareholders’agreement, the shares first had to be offered to the other shareholders.

The matter was brought before the board of directors and it was decided that they did not wantthe Westbrook store manager to obtain the shares and thereby become a potential member of theboard. However, none of the current shareholders had enough cash available to buy the Kellertonstore manager’s shares. It was decided that the company would buy back the shares at their bookvalue. The Kellerton store manager agreed to wait until the end of the year so that the properbook value of the shares could be assessed. At the end of that year, the actual book value of the



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shares was measured by dividing PCI’s book value of shareholders’ equity by the number ofcommon shares outstanding, and the Kellerton store manager was satisfied that he received a fairamount for his shares.

After the assembly of the new management team, PCI continued to grow at a rapid pace. Notlong thereafter, another hardware store and adjacent lumberyard were opened in Newtown, arapidly growing region located south of Cedarville. It quickly proved to be the most profitable ofPCI’s three outlets.

In spite of PCI’s success, Phil was aware from the advice that he had received from his fatherthat things could always take a turn for the worse. To provide for this, he devoted much of histime to strengthening PCI’s market position in the contracting business segment by developingsolid business relations with the contractors who were building houses in each of the areas wherePCI had retail and lumberyard facilities. In addition, he placed emphasis on reducing the firm’sdebt to a level below that of its main competitors so as to increase PCI’s chances of surviving adownturn in its business.

At the end of 1997, Phil retired and sold his shares to his cousin George. As the majorityshareholder, George then succeeded Phil as President and CEO. Consistent with Phil’s and hisown wishes that PCI essentially remain a family business, George appointed his oldest sonVincent to succeed him as Vice-President, Marketing. Vincent had previously managed one ofPCI’s retail stores after working for a similar business in another province upon his graduationfrom university. In addition, George hired his daughter Karen as the credit manager, whose maintask was to administer the collection of outstanding accounts. Further, he hired his youngest sonCharles to be the purchasing manager reporting to Peter Martin. In the same vein, RéjeanPedneault hired his daughter Dorothy, who had an accounting background and was in the processof completing her graduate business degree, as the accountant. Peter’s sons and daughters wereinvited to become employees of PCI, but were not interested in doing so. George also hiredRobert Grondin as Vice-President, Operations, becoming the first member of the board ofdirectors who was not a shareholder. Grondin had previously worked as a manager at KontactCo., a competitor of PCI. The organization chart for PCI under George’s leadership appears inExhibit 1.

PCI’s Clientele and Business Segments

PCI currently operates in the same two business segments mentioned previously: 1) sellinglumber and related products to contractors who manage large residential projects in developingareas, and 2) the retail hardware industry.

Lumber and Related Products

PCI’s core business is to sell lumber and related materials to contractors. The contractor industryis characterized by very low barriers to entry and, during “boom” periods such as thatexperienced recently, new contractors enter the industry almost daily. As a result of suchintensified competition, it is important that contractors look for ways to cut their expenses.



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Consequently, many favour assembled lumber products, as they require less labor and thus lesslabor costs.

To capitalize on this business, PCI has put together a sales force comprised of six salesrepresentatives who are paid on a salary-plus-commission basis. Each of the sales representativesis associated exclusively with one of the three PCI outlets, and they each have their ownportfolio of regular clients that they attend to and visit periodically. They are also responsible forexpanding PCI’s contractor customer base. The representatives are motivated to solicit newclients, as the resulting commissions associated with new contractor clients can be very lucrative.Sales representatives typically seek out new potential contractor clients by visiting as manyconstruction sites as possible in their area.

In attending to their regular contractors, sales representatives make their own schedules and visitthe contractors on a weekly or biweekly basis to take their orders and to discuss their currentbusiness projects. Once an order is booked, the representative prepares a purchase order andforwards it to his/her designated lumberyard. The lumberyard manager then takes over the salestransaction by preparing the requested materials and arranging delivery to the contractor’sconstruction site within a reasonable period of time. It is important that the sales representativescoordinate well with their respective lumberyard managers, as contractors are often verysensitive about delays in delivery of their orders to the extent that such an event could jeopardizethem as a client. Subsequently, each sale is recorded by the accounting department and therepresentatives are then paid a predetermined commission.

A charge account is established for each contractor subject to a credit check by PCI of thecontractor’s payment history with other organizations. Typically, contractors make payments ontheir accounts on a monthly basis. Such an arrangement is not uncommon in the industry;however, it is somewhat risky, as it is also not uncommon for contractors in the constructionindustry to file for bankruptcy and then restart their businesses under new names. Despite itsrisks, PCI has continued to follow this practice, as has its competitors, for fear of losing clientsshould they become more stringent in their collection policies.

Retail Hardware

The three mid-sized PCI hardware stores sell a wide range of hardware products that can be usedfor home improvement purposes on a “cash-and-carry” basis. Each store maintains a moderateinventory of a wide range of products that can assist in carpentry, electricity maintenance,plumbing, painting, and plastering tasks, among others. In addition to the generic range ofhardware products, each of the three stores has developed its own particular expertise insatisfying the specific needs of its customers. For example, the Westbrook store sells high qualitylumber products that are consistent with the needs of middle-class homeowners living in thearea. The Newtown store offers custom-built plans to build backyard storage sheds, a particularlypopular item in this economically active region where many young families are purchasinghomes. The Kellerton store offers hardware products that satisfy the needs of farmers, sinceagriculture is the major economic activity in this region.



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Customers in the retail hardware industry can be classified into two categories. The first categoryis the type of customer who will get involved in home repairs and improvement onlyoccasionally, i.e., when it is required. This type of customer is typically not loyal and is highlyinfluenced by price. He or she does not really look for quality of service and prefers a hardwarestore where a vast array of hardware items is readily available at an inexpensive price.

The other category of customers is comprised of those for whom home improvement is a hobby.These customers are less influenced by price and more interested in quality of service, which, inthis industry, takes the form of good advice and availability of special hardware items sold tosatisfy the home improvement expert’s needs. Traditionally, PCI has had a higher proportion ofthese customers among its hardware clientele.

The Competitive Environment

The contracting segment of the business is dominated by PCI and four other firms. Exhibit 2provides some information relating to PCI’s four main competitors. Each of these major playershad chosen specific regions in which to dominate outside of Cedarville (see Exhibit 3).Consequently, there is very little competition within these regions. However, they all competewith PCI for contracting business within Cedarville, although Marson’s Materials andRenovations Unlimited do not have retail outlets within Cedarville. The following provides salesand market share information for the various competitors in the contractor market for 1997-98.

Table 1Contractor Industry Market Size and Market Share Data

Total Sales(in thousands) Market Share

1997-98 1997-98Marson’s Materials $41,472 27.81%Kontact Co. $36,298 24.34%PCI Construction Inc. $31,109 20.86%Renovations Unlimited $18,566 12.45%Touchette Construction $13,794 9.25%Others $7,889 5.29%

The competition in the retail hardware industry is much fiercer. In the past, a chain of hardwarestores named Nuts’N’Screws (NNS) was the one dominant firm in the industry. In recent years,however, the competitive landscape has changed significantly. In PCI’s province, a largeEuropean consortium launched a large chain of retail hardware stores, known as BRIInternational, which has threatened the dominance of NNS. This led to the emergence of otherlarge retail chains throughout the Cedarville area. In response, NNS launched its own chain oflarge hardware stores known as NNS Warehouse.



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All of these large chains followed essentially the same strategy: they offered a very wide rangeof products to retail customers and attempted to undercut the prices of its competitors. Theconsiderable purchasing power of each of the large chains allowed them to offer prices that werelower than those previously offered in the areas in which they operated. In addition, the productsoffered by these stores were often not limited to hardware products. For example, some also soldhome furnishings such as plants and basic furniture. The intent was to draw as many customersas possible to the store to expose them to the low prices of the hardware products.

In more recent years, the retail hardware industry had undergone a rationalization in theCedarville area with the result that it has become more stabilized. After this “shakeout,” theCedarville market was left with two large chains, NNS and BRI International. A large number ofsmall to mid-sized hardware stores have remained, including PCI, each of which maintains asmall but loyal customer base and competes on quality and service, as they are not able tocompete with the large chains on price and product variety. The small to mid-sized storesrepresent a very small share of the market in the specific areas in which they are located.Collectively, they represent approximately 25% of the market, while NNS and BRI Internationalsplit the remaining 75%.

The following table provides information relating to PCI’s sales for a four-year period ending in1997-98.

Table 2Summary of Recent Years’ Sales Results

1994-95 1995-96 1996-97 1997-98Sales to contractors (in ‘000s) $25,202 $25,637 $26,764 $31,109Share of PCI’s total sales 65.41% 65.31% 66.85% 67.79%Market share 19.21% 19.11% 20.1% 20.86%

Retail hardware sales (in ‘000s) $13,325 $13,617 $13,274 $14,781Share of PCI’s total sales 34.59% 34.69% 33.15% 32.21%Market share 0.20% 0.32% 0.28% 0.27%

The following table provides a breakdown of PCI’s sales by store for 1997-98.



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Table 3PCI Construction Inc.

Sales Performance per Store(in thousands)

Retail Hardware Contractors1997-98 1997-98

Kellerton $4,490 $7,585Westbrook $4,119 $10,453Newtown $6,172 $13,071

PCI’s Strategies

PCI’s management believes that the firm is reasonably well positioned in the two major aspectsof its business, as it is able to meet most of its customers’ needs. PCI justifiably considers itselfto be a successful organization. Its philosophy and strategy were developed originally by OliverParsons and refined by his son Phil during his tenure with PCI. In spite of the changes in theindustry over the years, PCI’s management believes that the organization’s future success willcontinue to result from the management principles that have served them well in the past.

Product Lines

With its lumber and related products, PCI sells all that is needed to construct any type of houseto the point where the finishing work needed to complete the house can commence. Theseproducts include various lengths of lumber, finished wood, dry wall, screws, nails, etc. Forlumber products sold to contractors, PCI is able to deliver directly to the construction site mostof the necessary building materials ordered by the contractor within one day of receiving theorder.

In the retail hardware business, PCI maintains a wide range of hardware products, but not in thesame quantities as its larger competitors. As previously mentioned, PCI’s strategy is to competeon the quality of its service such as, for instance, offering advice to customers interested inrenovating their homes. According to this strategy, PCI sells its products at prices that aresomewhat higher than those of the large chains, while offering specialized products fitted to thespecific needs of customers, sound advice from experienced clerks, and a friendly, caringatmosphere. PCI’s management attributes the loyalty of its customer base to this strategy, andbelieves that it cannot be replicated by the larger retailers due to their low price orientation.

Inventory Management

PCI has traditionally carried a considerable amount of inventory of lumber and related productsdue to its practice of purchasing large quantities of products at a given point in time. This wasdone in order to take maximum advantage of quantity discounts and to protect against higher



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prices on products that have a tendency to vary significantly in price according to marketconditions. As a result of this approach to purchasing, the lumberyards’ inventories varyconsiderably from month to month; they can be particularly high during peak business periods,yet they also tend to be drawn down quickly at these times.

As for the hardware products, PCI’s approach is to keep inventories to a minimum. Generally,PCI’s hardware stores stock a wide variety of products but in moderate quantities due to storagespace constraints and their “customized” orientation. They seek to ensure that customers whohave general needs can find what they are looking for in their stores, while those who have morespecialized product needs can have them ordered according to their specifications.

Pricing

PCI’s current pricing strategy was developed by Phil in the early 1980s. The prices of buildingmaterials sold to contractors are, for the most part, cost-based. PCI typically sells these materialsat cost plus a gross margin that varies from product to product, but never exceeds 30%. Thisapproach has enabled PCI to cover direct costs such as delivery and order preparation as well asassociated indirect costs. As a result, PCI is able to pass along to contractors the quantitydiscounts that it attains through its purchasing practices. This approach also enables PCI toquickly adjust its prices in response to changing market conditions.

Prices of all construction items are set monthly by PCI’s president, who does not set the finalprice before consulting the vice-president of marketing and vice-president of operations. PCIpurchases most of its products at the spot market price and, because most of its competitors alsobase their pricing strategy on the spot market conditions, PCI does not have a lot of freedom withrespect to the price at which items are offered to contractors. These prices vary mainly accordingto the lumber market’s condition, which has been stable in recent years. Therefore, the meetingbetween the president and the vice-presidents is typically quite short, and serves mainly tovalidate the price list based on the conditions prevailing in the spot market. Unless there is amajor environmental disaster in one of the major Canadian forests, market conditions are likelyto remain stable for the next few years.

Sales representatives are not given much freedom by PCI management with respect to prices foritems sold to their most important clients. In the construction industry, quantity discounts offeredto contractors are very small, which also prevents PCI’s sales representatives from using theprice list to encourage their most important clients to keep on buying from them or to attract newclients. On the other hand, all of PCI’s competitors are subject to the same market conditions,such that companies compete on service quality rather than on price.

Due to the fierce competition from the large retail chains, the smaller to mid-sized retailhardware stores, such as PCI, attempt to meet the large chains’ prices on high demand items.However, as these stores do not benefit from the same level of quantity discounts as the largechains due to their more limited purchasing power, this often results in selling such items at aloss. PCI attempts to compensate for this by selling the more specialized products at prices that



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are slightly higher than the market price, which it justifies by providing a higher degree ofcustomer service.

Customer Service

As previously mentioned, customer service is an important competitive variable for PCI. Fromthe point of view of contractors interested in building products, good customer service meansbeing able to purchase a wide variety of competitively-priced products and to have themdelivered to their construction site within a day’s notice. The short time lag is important to them,as they are often forced by competitive pressures to build more houses in less time to meet theoften tight time schedules imposed by prospective homeowners. While price is also important tocontractors, product availability and fast delivery are comparatively more important.

PCI’s contractor customers are generally very loyal due to the strong business relationships thatthey have developed over the years with PCI’s sales representatives and management. Thesecustomers place great value on the PCI staff’s familiarity with their particular needs and theuseful suggestions that they receive from them. These factors seem to override the fact that PCIis often behind its competitors in adapting to product innovations that become available.

Customer service is also very important to the retail hardware side of PCI’s business. PCI’spractice is to hire enough full-time employees to handle comfortably all but the peak periods.These employees are well qualified to offer advice to less-experienced customers, and earnhourly wage rates that are slightly higher than those paid by the large retail chains.

In fact, PCI requires its regular employees to be competent enough to manage small constructionprojects. Such a requirement is very helpful when the time comes to provide advice to customers.For example, for a customer who would like to build a storage shed in his backyard, the typicalPCI employee would be competent and experienced enough to guide this customer through thewhole project.

He would start by discussing with the customer the location of the shed in the backyard,providing him with the usual pros and cons of putting the shed in a remote part of the backyardor close to the house. Once the customer decides on the location of the shed, PCI’s employeewould provide advice on the optimal size of the shed, offering different models that would fit thecustomer’s available space and would harmonize with the customer’s house. Once the model andthe size of the shed are set, it is then easy for the PCI employee to advise the customer on theexact types and quantities of construction materials required. These materials are delivered at thecustomer’s convenience and, under ideal conditions, the employee would follow up on the job bycalling back the customer to verify if everything went well. It must be noted, however, that PCI’semployees do not always have the time to follow up. PCI’s employees provide the same adviceand service for other types of small construction projects, such as basement renovations orlandscape related improvements.

Each retail store manager is viewed as a key employee who is responsible for ensuring that ahigh level of customer service is maintained. Store managers must be very familiar with allaspects of construction to assist customers themselves and to train their store’s employees to do



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the same. PCI’s staffing approach contrasts with that of the large chains, which typically hiremore casual employees, such as students, who often lack experience in home improvement andthus are limited in their ability to provide advice to customers in need. The turnover among thecustomer service staff of the large chains is high.

Marketing

Information regarding hardware product availability and prices is provided to hardware storecustomers using flyers and advertisements in local newspapers. PCI also uses flyers to advertisespecial offers, which vary by season. Special offers are made possible when PCI can order alarge quantity of the same items at discount prices. For example, early in the summer, theavailability of lawn mowers is advertised in flyers that are delivered directly to homeowners. Theflyers are developed by PCI’s marketing department. In the past, PCI attempted to advertiseusing other media, such as radio stations, but flyers and local newspapers have proved to be lessexpensive and are believed to be at least as effective as any other media in PCI’s view.

Information regarding construction product availability and prices is provided to contractors byPCI’s sales representatives. Every month, the sales representatives provide their clients with aprice list for the most popular construction items. Once the price list is set, the accountingdepartment enters the new prices into the information system and prepares copies of the price listfor each of the sales representatives’ clients. Then the sales representatives distribute them totheir clients.

As a result of the above strategies, PCI has been able to maintain a reasonable share of bothmarket segments in which it competes and continues to be profitable. Exhibit 4, 5 and 6 providesome recent financial information.

Facilities

PCI’s stores are located on one of the main streets of each city or town in which PCI is present(see Exhibit 7 for a diagram of the typical PCI facilities). Typically, customers get access to thehardware store from the parking lot, which is located close to the main street. They access thelumberyard located behind the hardware store by driving through the parking lot and passing bythe store, at the end of which there is a guarded entry to the yard. Customers can drive throughthe yard, pick up the materials that have been ordered and paid for in the store, and then leave bydriving through an exit located at the opposite side. Clerks are present in the yard to guidecustomers through and to assist in loading the customers’ vehicles with the materials purchased.

The lumberyards can be separated into two distinct sections. The first section typically containsone or two large sheds in which materials that can be affected by climatic conditions are stored.In the sheds, materials are stored on highly accessible racks beside which customers can stop toget their vehicles loaded with their purchased materials. The sheds are located at the entry to thelumberyard such that customers need to drive past them to get access to the second part of theyard.



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The second section of the lumberyard is an uncovered storage area where rougher surfaceconstruction materials (rocks, cement, concrete blocks, etc.) are stored. Customers who drivepast the sheds and the uncovered yard to reach the yard exit can view all of the constructionproducts available in PCI’s lumberyard.

Each of PCI’s lumberyards is arranged such that the high demand items are stored closest to theentry or exit. There is generally ample room in each yard to facilitate the movement of PCI’sheavy trucks used to fulfill contractors’ orders. However, at times when inventory levels arehigh, space is more limited for the movement of the trucks. Usually, PCI’s trucks are loadedearly in the morning or during the lunch break in order to avoid interference with regularcustomers.

The lumberyards are securely fenced to prevent theft as much as possible. Experience has shown,however, that even with very high fences, some materials still get stolen. Sophisticated thieveshave found ways to gain access to yards during the night. To keep thieves away from PCI’sproperties, guard dogs are used to patrol the yards at night.

Currently, PCI is considering whether to lease the forklifts that are needed to move constructionmaterials around the lumberyards (see Exhibit 8).

PCI’s retail stores are of average size. They are not as large as the large chains’ stores, but largerthan the small hardware stores that are typically found in small towns. The layout of the retailstores had been designed by Phil and has not changed for a number of years. Cash registers (twoor three, depending on the store) are located near the store’s main entrance, which also serves asthe store’s exit. At the back of each store, a counter, at which materials from the lumberyard canbe ordered by the customers, is situated. Clerks working at this counter are equipped with anintercom system that they use to keep in touch with the yard’s clerks, so they can assess productavailability and monitor customers’ movements.

Between the cash registers and the yard counter, items are typically grouped into sections such aspaint, plumbing, gardening tools, etc. Clerks are available in each section to assist customers andanswer their questions as needed. The various product categories are arranged in the store asefficiently as possible to maximize the range of products that can be stocked. Even when theseitems are stored optimally, however, space limitations prevent PCI’s stores from coming close tooffering as many products as do the large retailers.

Human Resources

In both the retail stores and lumberyards, the workforce at PCI is mainly comprised of hourly-paid employees, some of whom are regular employees while others work only during seasonalpeak periods or are called upon whenever there is a need. Through the years, PCI’s business hasfollowed a seasonal pattern whereby September through February are low-volume months whileMarch through August are high-volume months. PCI begins hiring seasonal employees inFebruary and their number peaks in April and May when demand at construction sites is at itshighest point. More specifically, PCI’s total number of hourly-paid employees can reach 165



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during peak periods and fall to approximately 100 during the lower volume periods. Thecompany also employs 12 clerks who perform various administrative tasks at the head office.Effective management of its workforce is important to PCI’s success, as labor is one of its largestexpenditures.

Each of PCI’s three facilities has a salaried store manager who is responsible for both the retailstore and the adjacent lumberyard. In addition, PCI employs a vehicles manager who isresponsible for all of the company’s vehicles, the garage, and the maintenance facilities. Theremainder of the workforce at each facility consists of hourly-paid employees who perform thetasks of clerks, cashiers, and various other tasks relating to the sale and delivery of constructionmaterials and hardware products.

The three store managers and the vehicles manager report to Robert Grondin, Vice-President,Operations, who in turn reports any significant problems pertaining to the day-to-day activities ofthe stores to the president. In addition to monitoring the daily activities, Grondin is responsiblefor ensuring that the stores and lumberyards remain attractive to customers both functionally andesthetically.

All of the managers at PCI have risen to their current positions after previously assuming othertasks within the company. For instance, all three store managers previously had otherresponsibilities within the retail stores; the vehicles manager previously was a mechanic in thegarage; and, during the summers while they were students, Charles worked in the stores andlumberyards, while Karen and Dorothy worked in the office as clerks.

Each store manager is paid a fixed salary plus a bonus when his/her store attains its profit target.The bonuses are calculated based on a percentage of the store’s profits in excess of the targetprofit. The vehicles manager, as well as Charles, Dorothy, and Karen, are paid bonuses based ona corporate target, calculated as a given percentage of the overall corporate profit in excess of thetarget.

The hourly employees who work at each of the three retail outlets are paid rates that arecomparable to those offered by many competitors and slightly higher than those paid by the largeretail chains. These rates are adjusted annually based on performance and seniority.

The head office clerks are paid salaries that are not necessarily adjusted annually. These clerkstypically do not have specialized training for these positions, as they largely constitute simple,repetitive tasks that do not require such training. Any one-time salary increases for these clerkswould only result after two or three years with the company. PCI considers office clerks to beeasily replaced and thus does not feel the need to increase their compensation in order to retainthem.

Finally, the sales representatives receive most of their compensation in commissions, and areconsidered by PCI management to be closer to business partners than regular employees.



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One of PCI’s main human-resource-related challenges is to ensure that the sales representativesget along well with their respective store managers so that the flow of materials to contractorsgoes smoothly. To date, conflicts between the two have been rare, and when they do occur, theytend to center on complaints by the sales representatives about the poor quality of service that, intheir view, has been provided to one of their clients.

One of the recent conflicts that occurred involving a sales representative actually had to do withthe way that a client was treated not only by a store manager but also by Karen Goodrich-Marois,the credit manager. The conflict started when the sales representative obtained a fairly largeclient who operated construction sites located between the Kellerton and the Newtown stores.Even though this sales representative typically deals with the manager of the Kellerton store, themanager of the Newtown store insisted that, because this customer operated a site located nearthe sites of his usual clients, he should be the one authorized to sell materials to this new client.The sales representative argued that the client would probably be better served by the Kellertonstore, as the Newtown store already had too many clients to deal with and could barely deliver itscurrent clientele’s orders on time.

Things got worse when the manager of the Newtown store mentioned to Karen that this clienthad a history of being very late in paying its accounts, prompting Karen to take extra care in hercredit investigation and to slow down the process of opening this client’s account. The salesrepresentative got very angry because he was on the verge of losing the client due to the delayand asked to meet directly with George to discuss the matter. The issue was quickly resolved asGeorge and Karen met to speed up the process of opening the account. It was decided that thesales representative could supply the new client through the Kellerton store, and that the amountof the sales would be split between the two stores for the purpose of performance evaluation.

Information Systems

In the latter part of the 1980s, PCI undertook the task of computerizing its accounting systems.To do so, Phil, who was still President at the time, hired Denis Marois, Karen’s husband, as aconsultant to develop an accounting software program that would suit PCI’s needs.

Denis successfully developed a program that was designed specifically for PCI. This programwas installed on PCI’s mainframe. It requires that all retail transactions processed through thecomputerized cash registers be downloaded into the mainframe system on a daily basis and thatall other transactions be entered by clerks at the head office. The program generates monthlyfinancial statements, as well as various other reports that summarize information such as PCI’scurrent cash position and detailed inventory records. After the clerks have entered all of thetransactions, Dorothy is responsible for producing and verifying the monthly reports before theyare submitted to the board of directors.

At the beginning of each year, Dorothy is responsible for entering the budget into the system.The board of directors sets the main sales targets that are to be incorporated into the budget, andDorothy contacts a number of sources external to PCI such as its suppliers, consultants, and thebank to assist her in estimating the coming year’s expenses. The cash budget and the budgeted



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year-end balance sheet are derived from the budgeted income statement after all of the projectedcosts, including variable, are determined. All of the above is performed using spreadsheetsoftware; then the data is entered into the mainframe system to enable the accounting softwareprogram to produce reports to compare actual to budgeted results throughout the year.

Typically, the system results in only a few discrepancies that Dorothy can usually detect andcorrect before the reports are sent to the board of directors. In fact, Denis has been so successfulin developing the program that he decided to launch his own firm to sell it directly to otherclients and adapt it to meet their needs.



Page 16 (23 pages)

Exhibit 1

PCI Construction Inc.Summarized Organization Chart

Board of Directors George Goodrich

President and CEO

Vincent Goodrich

Vice-President,Marketing

Robert Grondin

Vice-President,Operations

Manager

Kellerton

Manager

Newtown

Manager

Westbrook

Manager

Vehicles

Réjean Pedneault

Vice-President,Finance andController

KarenGoodrich-Marois

CreditManager

DorothyPedneault

Accountant

Peter Martin

Vice-President,Purchasing

CharlesGoodrich

PurchasingManager



Page 17 (23 pages)

Exhibit 2Highlighted Information About

PCI Construction Inc.’s Main CompetitorsIn the Contractor Market

Location # of RetailStores Strength Weakness

Kontact Co.

Facilities in Cedarvilleas well as regionssouth, east and west ofCedarville

11 Well-diversified

Greater focus onretail operations,which are in directcompetition withlarge chains

RenovationsUnlimited

Facilities in regionsnorth and east ofCedarville

2 Good financialsituation

Small businessattitude

Marson’sMaterials

Large facility in aregion north ofCedarville

1 Good financialsituation

Does not cover alarge territory

TouchetteConstruction

Facilities in Cedarvilleand a region west ofCedarville

2 Good quality ofservice Too much debt



Page 18 (23 pages)

Exhibit 3Map of Cedarville and Surrounding Area

K

CedarvilleWestbrook

P

K

K

K

T

MR

T

NewtownRegion

P

K

K

K

K

K

K

Kellerton RegionP

R

Legend:K Kontact Co. retail outlet

T Touchette Construction retail outlet

M Marson’s Materials retail outlet

R Renovations Unlimited retail outlet

P PCI retail outlet

N

W E

S

K



Page 19 (23 pages)

Exhibit 4PCI Construction Inc.

Three-Year Income StatementFor the Years Ending October 31

(in thousands)

1996-97 1995-96 1994-95

Sales $40,038 $39,254 $38,527Cost of goods sold 30,505 30,135 29,643Gross margin 9,533 9,119 8,884Operating expenses:

Labour 3,784 3,707 3,576Delivery 654 639 603Advertising 108 97 101Occupancy costs 581 670 743

5,127 5,113 5,023Operating profit 4,406 4,006 3,861Selling expenses 607 616 610Administrative expenses 1,916 1,878 1,841Interest 678 614 621Amortization 679 608 487

3,880 3,716 3,559Income before tax $ 526 $ 290 $ 302



Page 20 (23 pages)

Exhibit 5PCI Construction Inc.

Three-Year Balance SheetAs at October 31

(in thousands)

1996-97 1995-96 1994-95Current assets:

Short-term investments $ 168 $ 191 $ 157Accounts receivable 4,215 4,116 3,987Inventory 7,845 7,521 7,628

12,228 11,828 11,772Net capital assets 6,954 6,174 5,866Total assets $19,182 $18,002 $17,638

Current liabilities:Bank overdraft* $ 5,115 $ 5,041 $ 4,974Accounts payable 2,858 2,921 2,904Current portion of long-term debt 1,589 1,594 1,607

9,562 9,556 9,485Long-term liabilities 5,012 4,229 4,152Shareholders’ equity:

Common shares 1,075 1,075 1,075Retained earnings 3,533 3,142 2,926

4,608 4,217 4,001Total liabilities and shareholders’ equity $19,182 $18,002 $17,638

* Net of cash. As is typical of this industry, with significant investments in inventoryand accounts receivable, PCI is in an overdraft position. However, this is notconsidered problematic, as it is well within the overdraft limits set by the bank.



Page 21 (23 pages)

Exhibit 6Summary of the Major Financial and Management

Accounting Practices as Applied at PCI Construction Inc.

1. As an accounting policy at PCI, cost of goods sold only includes the purchase cost of thematerial sold through PCI’s outlets. Labour costs and other expenses are included in theoperating expenses. The gross margin is calculated by subtracting cost of goods sold fromsales.

2. For the purpose of preparing the budget, labour costs are computed first by using aregression model to estimate the number of labour hours that will be required for eachoutlet. This regression model relates the labour hours to the sales in each of the outlets.

3. PCI computes an operating profit for each outlet. To simplify the calculations, severaloperating costs are combined. Delivery expenses include the cost of vehicles maintenanceand gas. Advertising expenses include the cost of the flyers sent to homes by the outletsand other costs related to business relationships. Occupancy costs include heat andelectricity, maintenance of the stores and yards, cost of cleaning, costs related to thealarm system, waste disposal and taxes, and other minor costs.



Page 22 (23 pages)

Exhibit 7Diagram of Typical PCI Construction Inc. Facilities

Exit to secondary street

Store

Shed A

Shed

B

Parking Lot

Storage Area # 2

Storage Area #1

Storage

Area

# 3

Storage Area # 4

Entrance through main street

Gate

Gate

Fence



Page 23 (23 pages)

Exhibit 8Buy or Lease the Forklifts

PCI was considering the possibility of leasing rather than buying the forklifts that are used ateach lumberyard to move around the construction materials inventory. PCI currently owns 19forklifts that are at various stages of obsolescence, i.e., ranging from new to almost obsolete.Each new forklift costs $40,000 and has an expected life of 7 years. The forklifts currentlyowned by PCI could be sold immediately for $380,000 or used until they become completelyobsolete, and then be replaced by leased forklifts. There are three different types of leasingarrangements available to PCI:

Lease 1:

A forklift is leased for a 6-year period. The present value of the lease paymentsafter tax is approximately $32,000 and, at the end of the lease contract, the forkliftcan be bought for a minimal amount. The lease payments are made at the end ofeach month, and the forklifts must be made available to the lessor for regularinspection and maintenance.

Lease 2:

A forklift is leased on a monthly basis according to a contract that does notrequire a long-term commitment from PCI. If a forklift were to be leasedaccording to this contract for the same 6-year period as Lease 1, the present valueof the lease payments after tax would be approximately $32,000. The leasepayments are made at the end of each month, and the forklifts are inspectedmonthly by the lessor.

Lease 3:

A forklift is rented on an hourly basis, according to PCI’s short-term needs. Theforklifts are inspected by the lessor when they are returned. It was estimated thatthe average cost would be $120 per month per forklift.

One benefit of leasing is that it would provide more flexibility to PCI in terms of using theforklifts. An optimum combination of leases for PCI was determined as follows:

1. To ensure that PCI always has the minimum required forklifts on hand, lease 9 forkliftsunder a long-term contract (Lease 1).

2. Lease 9 forklifts on a monthly basis (Lease 2) during the five peak months.3. Rent 9 forklifts on an hourly basis (Lease 3) for selected days during the seven busiest

months.

Documents

PCI Construction Inc. June_2000_Backgrounder CMA Exam